Price control logic in Rajan growth theory

Our Special Correspondent

Rajan: Points to ponder

Mumbai, Feb. 26: Reserve Bank of India (RBI) governor Raghuram Rajan today waded into the inflation versus growth debate once again — and asserted that “the best way for the central bank to generate growth in the long run is for it to bring down inflation”.

The issue threatens to snowball into another major standoff between the finance ministry and the RBI over the conduct of monetary policy, especially after the finance minister has insisted that the central bank must strike a balance between the compulsions of arresting inflation and the exigency of kick-starting a faltering economy.

“The RBI is committed to getting the strongest growth possible for India – there is no difference between us and North Block on this. We believe the best way we can foster sustainable growth in the current situation… is through monetary stability — by bringing down inflation over a reasonable period of time. More specifically, we intend to bring consumer price index (CPI) inflation down to 8 per cent by January 2015 and 6 per cent by January 2016,” Rajan said while inaugurating the annual conference of the Fixed Income Money market and Derivatives Association of India and Primary Dealers Association of India.

The conduct of monetary policy has itself become a subject of debate with the Justice B.N. Srikrishna, who headed the Financial Sector Legislative Reforms Commission, coming out with a report in March last year that recommended that the Centre should set a “quantitative monitorable objective” for the central bank while setting out its monetary policy function. The FSLRC had also said that a seven–member monetary policy committee should be established and inflation need not be its sole objective.

“If, in the future, the government felt that the appropriate goal of monetary policy was a fixed exchange rate, or nominal GDP, then it would be able to specify these goals,” the Justice Srikrishna report had said.

Last month, a committee set up by the RBI under deputy governor Urjit Patel came out with its report on the framework for the conduct of monetary policy that sharply differed with the FSLRC report. The Patel report said the RBI should focus on reining in CPI inflation and suggested a “glide path” to bring it down to 6 per cent — a suggestion that Rajan has enthusiastically embraced.

On Wednesday, Rajan said it would be “good for the medium term inflation target to be set by the executive or the legislature, presumably based on advice from the Reserve Bank.”

While rubbishing the notion that the policymakers on Mint Street had turned into a bunch of “inflation nutters”, Rajan had a forthright suggestion for the finance ministry. “International experience suggests that… once the central bank’s objective is given, and the operational target fixed, the government should leave the technocrats in the central bank to do their job,” he said.

Rajan has raised interest rates three times since he assumed office on September 4 last year, sparking alarm in both government corridors and company boardrooms at a time the Indian economy is bracing for another dog year with GDP growth forecast at around 5 per cent.

Last month, the RBI governor had raised the policy rate by 25 basis points to 8 per cent to beat down on retail inflation that is riding at just under 10 per cent.

Rajan said the Urjit Patel committee’s suggestion to bring down retail inflation to 6 per cent by 2016 was “doable without extreme hardship”.

The simmering tension between the finance ministry and the RBI over the recent increases will only escalate as the general elections draw near and the government’s report card comes under intense scrutiny.

In fact, the Srikrishna report had also recognised the pressures that the central bank would face in such a situation. It had said, “If a central bank lacks independence, it comes under pressure to cut rates in the period preceding elections. This tends to kick off increased inflation after elections. The lack of independence at a central bank is thus associated with reduced fairness in elections and enhanced macroeconomic fluctuations.”

Rajan also took a sharp dig at industrialists who have been clamouring for rate cuts.

“I have yet to meet an industrialist who does not want lower rates, whatever the level of rates. But will a lower policy interest rate today give him more incentive to invest? We at the RBI think not. First, we don’t believe the primary factor holding back investments today is high interest rates. Second, even if we cut rates, we don’t believe banks, which are paying higher deposit rates, will cut their lending rates. The reason is that the depositor, given her high inflationary expectations, will not settle for less than the rates banks are paying her. Inflation is placing a floor on deposit rates, and thus on lending rates,” he added.